The U.S. Securities and Exchange Commission (SEC) categorizes real estate deals and private equity as securities. In order to offer these securities legally, an issuer must be registered with the SEC. The process of registering securities with the SEC can be lengthy and cumbersome. This presents a barrier to entry for many companies. This is where a discussion of SEC Rule 506(b) vs. 506(c) comes in.
The SEC has lowered the cumbersome obstacle of registering securities with the SEC by dividing Regulation D into two separate sub-regulations: Rule 506(b) and Rule 506(c). These rules enable small businesses to offer unregulated securities more easily if they fulfill certain requirements. Which Rule a company files under depends on its specific goals.
Rule 506(b) vs. 506(c)
Under Rule 506(b), an issuer may offer unregistered securities to any accredited investor and as many as 35 unaccredited – “sophisticated investors.” The definition of a sophisticated investor is not as clear as that of an accredited investor. However, many high-income professionals would be classified as sophisticated investors, but not reach the income or other criteria established by the SEC for accredited investor status.
On the other hand, Rule 506(c) requires all participating investors in a securities offering under this exemption to be accredited investors. The Rule also requires a verification process that involves providing proof of income, assets, or other qualifying factors. Many times, a third-party verification service is used to make this process easier.
Certification
Under Rule 506(b), the issuer can depend on the self-certification of the investor. Under Rule 506(c), the issuer must perform reasonable steps to verify the investor’s accredited status. The use of a third-party verification company is recommended in this case.
Advertising and Prior Relationships
Under Rule 506(b), prior to presenting a securities investment opportunity to a potential investor, the issuer must be able to prove it has a prior existing relationship with the investor. As a result, companies offering securities under Rule 506(b) may not advertise their deal through general solicitation whether in print, on TV, or online. However, they may advertise their company and brand in general.
When a potential investor does contact an issuer, the issuer will often have multiple meetings with the investor without bringing up the investment opportunity. This helps the issuer demonstrate having a prior substantive relationship with the investor.
As it concerns Rule 506(b) vs. 506(c), under Rule 506(c), the restrictions mentioned under Rule 506(b) do not apply. The issuer may conduct general solicitation and advertise any specific deal it desires. The lack of restriction on this makes the process of reaching potential investors easier, but all of the investors must have accredited status at the time of investment.
Rule 506(b) does give you a lower barrier to entry as an investor in that you are not necessarily required to have accredited investor status. But Rule 506(c) makes it much easier to discover and invest in unregulated securities without going through the long process of establishing a previous relationship with the firm. You also have the knowledge that all other investors are accredited.
